Decoding PNB (Punjab National Bank) fraud case

The Punjab National Bank (PNB) lost $1.77 billion in Nirav Modi case. The magnitude of the scam is very huge. This puts serious questions regarding how the scam took place either due to combination of external & internal processes or some other reasons, the technicalities behind the scam related to SWIFT, CBS, auditing and the extent of scam had great impact on stock market. 

On Feb 14th 2018, the Punjab National Bank which was the second largest Public sector banks reported to stock exchanges, Central Bureau of Investigation and Reserve Bank of India regarding exceptional transactions of approximate value $1.77 billion tending to be fraudulent. Lack of scrutiny, auditing, regular checking the transactions were some of the major reasons behind this fraud. 

The 2008 recession (Lehman Brother's fall) had severe impact on banking system globally but at that time depositors were not rushing to withdraw deposits. In this PNB case, exactly opposite was happening.

PNB filed the complaint on 29th Jan 2018 with CBI telling the fraudulent transaction with Nirav Modi’s firm along-with related bank official. 

The fraudulent transactions were for the benefit of a few select account holders. The note had not mentioned the name of the  Diamond merchant but media found out the name which was the Mumbai branch of PNB where the branch had allegedly issued LOUs for raising the buyer’s credit for this diamond trader. The fraudulent transactions or LOU issuance had been taken place at Mumbai branch. 

LOU is the form of bank guarantee under which bank can borrow money from the bank branch of overseas Indian bank. Due to this, its customer is getting money from another Indian bank’s foreign branch in the form of buyer’s credit.

PNB employees (54 officials) issued the fake Letter of Undertakings (LOU) which could lead to fund NOSTRO account of PNB by the Axis and Allahabad bank (Hongkong branches). Where this NOSTRO account of PNB could fund to overseas parties including that of Nirav Modi.  Two PNB employees were issuing LOUs in unauthorized way from last 7 years. Afterwards, one of them retired and the new employee came on his designation. In January, when the officials of firm demanded fresh LOUs from PNB, the new PNB officer asked for the collateral security. The officials of firm mentioned that this had been never asked by the PNB manager in the last 7 years. 

Now the bank got signal that something wrong has been taken place. The new 

Bank officer got doubt on the past 7 years LOU issuance and he looked into the concerned matter in detail. After detail investigation, it found near about 100 LOUs issued to these firms without asking for collateral security. PNB became the victim of the fraud. It faced the problem amounting to about 11,400 crores.

Modi needed money to import pearls & diamonds. He wanted to have foreign currency loan and his earning through exporting was in foreign currency. The most important thing is that he wanted to borrow without his loan account. Hence, he arranged LOU from the PNB to get cheap buyer’s credit in foreign currency, which is for a short term.

Ideally, Modi should have exported the pearls, diamonds & use the earnings for settling the due amount of LOU as & when demanded by the bank according to its standard procedure. Further, PNB need to have paid back the loan it has raised in its NOSTRO account from the overseas banks. But he utilized the money for other purposes without paying it to the bank. These activities were happening from last 7 years. Rather Modi used to pay back the principal & interest on old LOU by new one.

The internal banking system was exposed to fraudulent activities. It is must to use the standard operating system for prompt and cleanbanking.

It was the responsibility of external as well as internal auditor to trace the transaction also contingent liability figure or the other question arises whether those auditors were also involved or not. Concurrent auditors whose job is of transaction verification. They couldn’t notice the case at that time was big question. Hence, all auditors like concurrent, internal and statutory were failed in finding out the problem.

The fraud had its impact on Life Insurance Corporation (LIC) and which was the single biggest investor & it lost Rs 1,400 crore over the three trading sessions. Also, this bank crisis had impact on the currency exchange rate as PNB scam led out to fall in the exchange rate. 

It is important to investigate how the operational risk raised and the process got unnoticed. There was no planning in the risk management system. The system was not effective and efficient. There were rise in operational risk without any identification of its gradual growth itself suggests that focus on risk management was necessary.

The RBI’s role was also under question. Why did not RBI provide attention during auditing of the transactions. Where it went wrong while assessing those transaction. Later on RBI took necessary improved steps that were welcome but the fault in the past made the loss which is difficult to recovery.